(Updates with China remarks and additional detail from the fourth paragraph.)

SYDNEY -(MarketWatch)- The global economy and markets are heading into "a new danger zone" that will require strong policy action to restore confidence, Robert Zoellick, president of the World Bank, said Sunday.

Europe's spiralling sovereign debt crisis and a downgrading of the U.S. credit rating have sparked waves of fresh volatility and fuelled fears of another global recession as policy makers from developed nations quickly run out of tools to absorb the new shocks.

Endorsing moves by the European Central Bank to buy bonds from the distressed euro-zone nations such as Spain and Italy, Zoellick said that measure will only solve near-term liquidity issues and urged leaders to endorse structural reforms to boost productivity, job creation and free trade in a push to get growth back on track.

"We are entering a new danger zone," Zoellick told reporters in Sydney after speaking at a function. "It would be important that the primary economic actors take steps both short and long term to restore confidence."

But the developing world faces challenges too, the World Bank President said, who has held the office since 2007. Identifying a risk of overheating in China, Zoellick said July's 6.5% inflation number--a three-year high--has likely influenced policy makers to allow the yuan to appreciate to combat price pressures, and he called for further appreciation.

"The reason I think you have seen some of this appreciation of the currency is that I think that (July inflation) probably tipped the balance internally that currency appreciation is a way to counter inflation," Zoellick said in earlier panel remarks.

China's yuan hit a fresh high against the dollar late Friday after the central bank guided its currency upward for the third straight session, marking the yuan's biggest weekly rise since it was unpegged from the greenback last June.

Zoellick, who is a former deputy secretary of the U.S. State Department, said an inflation rate in China of up to 10% would pose major problems for the country's leadership. He warned that if there is a major slowdown, Beijing may have less policy stimulus available than before due to likely bad loans in the financial system and quickening inflation.

On the role of the U.S. dollar as a reserve currency, Zoellick said he expects the greenback to remain the primary reserve asset but he called for a multilateral approach which, in time, will see other currencies including the yuan grow as a proportion of global reserve holdings.

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